How to Trade with Technical Charts By Akhilendra Pratap

www.akhilendra.com
How to Trade with Technical
Charts
By Akhilendra Pratap
Singh
How to Trade with Technical Charts
Page 1
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Acknowledgment
I want to thank my family members for their support while I was busy writing this
book.
I have used Yahoo finance and Google finance for the charts.
They provide free charts of all kinds.
Disclaimer
The author disclaim all legal or responsibilities for any losses which investors may
suffer by investing or trading using the methods mentioned in this book. Readers in
this book are advised to seek expert opinions before taking any trading call.
Copyright
All rights reserved. No parts of this publication may be reproduced, stored in a
retrieval system, or transmitted, in any form or by any means, electronic, mechanical,
photocopying, recording, or otherwise, without the prior permission of the author.
Published in 2010
By Akhilendra Pratap SIngh
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Contents
Preface
5
Chapter 1 – Introduction
7
Types of charts
9
1. OHLC “Bar Charts” — Open-High-Low-Close charts, also known as bar charts, plot the span between
the high and low prices of a trading period as a vertical line segment, and the open and close prices are
represented with horizontal crossing on the range line, usually a tick to the left for the open price and a tick
to the right for the closing price.
9
2. Candlestick chart — they are of Japanese origin and similar to OHLC, candlesticks are also widely
used. They are composed of two bars which represent high and low and are called candlestick. Often black
or red candle bodies represent a close lower than the open, while white, green or blue candles represent a
close higher than the open price. These are one of the most widely used in current practice.
10
Line chart — Connects the closing price values with line segments. In this form of chart, open, high and
low prices are ignored. Line charts are not very commonly used.
11
Chapter 2-Technical Charts
13
Candlestick charts
13
Chapter 3- Trend Lines
21
Drawing a Trend line
21
Up Trend line
22
Down Trend Line
22
Trend channels
24
Chapter 4 - Chart Patterns 1
27
1.
28
Head and shoulders Pattern
2.
Inverted Head and Shoulder Pattern
31
3.
Failed Head and Shoulder Pattern
33
Chapter 5 - Chart Pattern 2
35
1.
Double Top (Reversal) pattern
35
2.
Double bottom Pattern
37
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3.
Broadening formation
40
Chapter 6- Chart Patterns 2
43
1.
43
Ascending Triangles Pattern
2.
Descending Triangles Patterns
46
3.
Symmetrical Triangle Pattern
49
Chapter 7 – Chart Pattern 3
52
1.
Bullish Flag - These are pointing the lower directions and are formed of two parallel lines. These are
smaller structures so one needs to pay more attentions to figure out them. These parallel lines act as support
and resistance. Unless until, support is breached or resistance is broken, a valid pattern is not confirmed. 52
Bearish Flag
55
Pennant Patterns
57
2.
Bull Pennant
3.
Rectangles
57
60
Chapter 8 - Moving Averages
63
1. Simple Moving average
63
2. Exponential Moving Average (EMA)
65
Crossovers
67
Chapter 9 - Indicators
71
1. Lagging Indicators;
71
Leading Indicators
77
1. Rate of change Indicator
86
2. Bollinger Bands
88
Chapter 10 – Trade Planning
91
Planning a trade
91
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Preface
In the past, i have gone through many books on stock market. But most of them were over
the top for me. Most of them speaks a language which is not only very difficult to
understand but also quite tedious to implement. These books covered the length and width
of the market and the technical analysis, but with too much of data in hand, it often turn out
be a challenge to come up with a concrete plan. It becomes very difficult to list out the most
appropriate and applicable data so that one can have a clear roadmap to follow. And in
absence of a roadmap, we often land in trouble. So, I decided to write this compact book on
technical analysis.
This book is not a quick buck magic book, so if anybody is looking for any kind of quick
money making tips, then please look for some other book. Though, i am not sure if there
can be one. Objective of this book is to give a insight into the world of technical analysis.
This book is going to appeal to those readers who are looking for a compact book which
doesn't contain any unnecessary material but does contain all the required information.
In this book, we are going to cover only what is required and leave everything outside which
is only meant to add pages to a book. Through this book, we will go through the basic and
in depth details of technical charts and most widely used indicators. Indicators are widely
used in the today's market to forecast the market movement. Along with these, we will also
cover trend lines which have gradually become one of the most important and widely used
tools across the globe to predict the market behaviour.
It is very important to understand that technical analysis is a skill and an art, which can be
only acquired over a period of time with the practice. We will discuss many real charts and
example. And if someone is looking to really get into technical analysis, then one must
devote sometime to it and at least practice five charts everyday. Learning technical analysis
requires much more than a book. This book or any other book, can only throw light on path,
it is responsibility of the reader to follow the path and practice this art on a daily basis in
order to gain maximum from it.
Markets always follow pattern. They move in a fixed pattern and one can predict the future
course by studying the previous trends and patterns. This phenomenon is known as
technical analysis. In technical analysis, it is assumed that the market price of a security is
the accounted price which has already considered every fact like fears, sentiments, profit,
loss etc. A chart is the graphical representation of the price of a security against time.
In technical analysis, these graphs are studied and used to predict future movement.
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This is a candle stick chart of Reliance Industries.
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Chapter 1 – Introduction
Stock market attracts all kind of people like gamblers, corporate big shots and the last but
not the least, an average investor. An average investor can be anything, from a full time
trader to a part time small investor. There are varieties of people who invest in stock market.
There are varieties of reasons behind that. Most of them want to be a billionaire over night
and therefore invest in share market unrealistically and hurt themselves. In fact most of
traders make no money and are most of the time, in loss. Then to recover their loss, they
trade more and hence more loss. And then there are very few, who are looking to multiply
their wealth over a period of time. It is very important to understand that stock market
cannot make you billionaire over night but they definitely can increase your wealth many
folds. Stock markets are like a marathon where one needs skill, patience and self control to
overcome hurdles.
Before you read anything about stock market or technical analysis, one must understand
that its all about discipline. Or else, one may get few nice shots but is bound to fall short
when it matters most i.e. in long run. So distinguishing between good and bad bet is all
about investing in share market. There are two main stock exchanges in India namely BSE
(Bombay Stock Exchange) and NSE (National Stock Exchange). Both are almost equal in
volumes and cash.
Indian stock market is regulated by SEBI (Securities and Exchange board of India). Stocks
are traded on these exchanges. Normally, trade happens in two segments- cash and
derivative i.e. Future and option. An individual can trade in both segments. Traditionally idea
behind trading is to buy a stock at lower level and then sell it when prices move up. The
process of short selling is also getting popular among traders. Short selling is the process
where a trader is able to sell a stock without owning it and then covering the position by
buying it.
Stock market is all about entry and exit. Timing is the most crucial factor in playing stock
market. An average investor is always looking for clues and tips to know about the right
stocks and right time. We often turn to stock analyst for tips, but at the same time we hardly
understand what they say. We just follow their recommendations and sometime we make
profit and often loss. If we can understand technical analysis, it will help us and then we will
be able to reap the real benefits of market. A well informed trader can make profit from
falling as well as rising market.
There are two kind of analysis;
1.
Fundamental Analysis
2.
Technical Analysis
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1. Fundamental Analysis- Fundamental Analysis deals with financial health of the company
and factor affecting it. It involves looking into company’s earning, liabilities, assets,
expenses and overall financial statements. It requires careful study of cash flow statement,
balance sheet. PE ratio and EBITDA margin. Fundamental Analysis plays a huge role in
long term market movements but in short term movement, markets may differ fundamental
analysis.
2. Technical Analysis- Technical Analysis deals with the predicting the stock or index prices
by looking into the historical data, charts and volumes. It is more accurate in short term and
widely used by traders. We will further look into the technical analysis as it is more
important for profit generation in a volatile market.
Technical Analyst use charts to study price movements, patterns and then predict future
prices. Patterns such as head and shoulders or double top reversal patterns or indicators
like moving averages and other factors such as lines of support, resistance and channels
are used in forecasting the expected future trend.
They also look at other data like volumes and Advance/decline data. Commonly used terms
in technical analysis are;
Resistance — a price level which acts as a ceiling above current price.
Support — a price level which acts as a floor below current prices
Breakout — the concept where prices breaches the support or resistance level.
Trending — a phenomenon by which price movement tends to move in one direction for an
extended period of time.
Average true range — averaged daily trading range, adjusted for price gaps
Chart pattern — distinctive pattern created by the movement of security prices on a chart
Dead cat bounce — the phenomenon whereby a spectacular decline in the price of a stock
is immediately followed by a moderate and temporary rise before resuming its downward
movement
Elliott wave principle and the golden ratio to calculate successive price movements and
retracements
Fibonacci ratios — used as a guide to determine support and resistance
Momentum — the rate of price change
Point and figure analysis — a priced-based analytical approach employing numerical filters
which may incorporate time references, though ignores time entirely in its construction.
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Types of charts
There are varieties of charts which are used by the technical chartists to predict future
market trend. These charts are graphical representation of the price movement against
time. Mainly used charts are;
1. OHLC “Bar Charts” — Open-High-Low-Close charts, also known as bar charts, plot the
span between the high and low prices of a trading period as a vertical line segment, and the
open and close prices are represented with horizontal crossing on the range line, usually a
tick to the left for the open price and a tick to the right for the closing price.
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Figure 1.1-This is OHLC chart of Nifty by Yahoo Finance
2. Candlestick chart — they are of Japanese origin and similar to OHLC, candlesticks are
also widely used. They are composed of two bars which represent high and low and are
called candlestick. Often black or red candle bodies represent a close lower than the open,
while white, green or blue candles represent a close higher than the open price. These are
one of the most widely used in current practice.
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Figure 1.2- A candlestick chart by Yahoo finance
Line chart — Connects the closing price values with line segments. In this form of chart,
open, high and low prices are ignored. Line charts are not very commonly used.
Figure 1.3- A Line chart by Yahoo finance
These are the commonly used charts in today's practice. Whatever we choose as a matter
of choice, one need to stick to the basic and should not force a pattern on it. We will go
through all the important indicators and patterns in later chapters.
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Points to remember
You can select any chart as per your choice.
Try to become the expert of any one chart of your choice and don’t play with all
because it requires practice to master a chart and jumping from one chart to another
will lead to confusion.
Select your goal and stick to it.
Never force trades and wait for a pattern to complete.
Use multiple indicators to confirm a pattern.
Use multiple time frames while using charts.
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Chapter 2-Technical Charts
Candlestick charts
Before we go into the world of technical charts, we must understand few basic assumptions
which are made in charting and technical analysis.
 Everything is discounted in market- it indicates that stock price in market includes
everything i.e. Hopes, fears, muscle power, profit, loss etc. Trading is all about demand
and supply. Demand is created by the buyer and supply is provided by the seller.
 Trend – market follow trends. History repeats itself and market move in trend. Every
move is in an order and no movement is random. This trend move in form of highs and
lows.
Charts are very important part of technical analysis. They are studied by the expert traders
to forecast stock or market movement.
Though there are more than one charting techniques available but there is nothing like
anyone is superior to other. One can use any method based upon individual choice but
make sure that you stick to one because more you practice more you learn. And if you keep
moving from one charting technique to another, it will only add to the confusion.
We have studied the basic charts details in the previous chapter. In this chapter we are
going to cover candlestick charts in detail because I use it personally. So, i don't have much
information on other charting technique. First we will cover its details in this chapter and
then the important patterns in later chapters.
Candlestick charts
In previous chapter, we have already gone through candlestick chart. But that was a very
basic overview and now we are going to have a closer look on it. As mentioned earlier,
these candlestick charts was developed in Japan and were mainly used by the rice traders.
But over the years, they have developed as one of the most favourite and commonly used
chart by the equity traders across the globe.
Open, high, low and close values for a time period is used to create candlestick chart. The
hollow or colour portion is called body and thin line above and below is called shadows
(sometime called as wick or tails). Shadows represent the high and low price of a stock.
Hollow represent the days with close in High and Filled represent the day with close in Low.
In case of a hollow bar, high is marked by the top of the upper shadow and the low by the
bottom of the lower shadow.
In case of a filled bar, top of the body represents the opening price and the bottom of the
body represents the closing price.
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Many technical chart analysts use them because they feel it is easier to learn and interpret.
When the prices close below the opening price, it is represented by a filled bar i.e. when
price falls it will create a filled bar whereas when prices move up i.e. when price closed
above the opening price, it will create an empty or hollow bar. The size of the bar, empty or
filled, is very important because it reflects the strength of the respective move. For example,
if there is long or tall filled bar, it means that the fall was very strong and bears were playing
at full strength whereas in case of a hollow bar, it reflects the strength of bulls.
Points to remember while using a candlestick chart,
1. Longer body represents intense move, up or down.
2. Upper and lower shadows are very important because they represent the highs and
lows of the day, when they are long it shows that stock moved in a long trajectory
before closing at a certain period whereas short shadow represent that stock moved in
a narrow range before closing down.
3. Candlesticks with a long upper shadow and short lower shadow indicate that buyers
dominated the session, and prices moved in higher trajectory for most of the session
but later bear dominated the session and the lower close created a long upper shadow.
Conversely, candlesticks with long lower shadows and short upper shadows indicate
that sellers dominated majority of the session and drove prices lower. However, buyers
later became active to push prices higher by the end and a higher close created a long
lower shadow.
Now we will go through few important formations in candlestick charts;
Spinning tops – candlestick with long upper and lower shadows with a small body is called
spinning tops. Spinning tops represent indecision and often formed during a volatile session
and bull and bears are confused and stock doesn’t take any decisive move.
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Doji- It is one of the most important formations in a candlestick chart. It represents
indecision which basically happens in a volatile market. It might be an indication of a trend
reversal. They are formed when opening and closing prices are almost equal and they look
like a plus symbol. They are neutral on their own but indicate preceding trend bias which
may be bull or bear. It represents weakness in the current trend, they are not trading signals
but they can be used with other patterns and data to figure out the future trend reversal.
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Figure 2.1- Doji may not trigger a trading signal; they should be used in conjunction
with other patterns and indicator.
Hammer
It is generally a bullish pattern; the lower wick should be longer than the body. In this
formation, body is small and at the upper end of the body. Colour of the body is not
important.
Hanging Man
It can be bullish or bearish depending upon its colour, though generally it is expected to be
bullish but can be bearish if the security opens at the lower level next day.
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Shooting star
It indicates end of an uptrend. It does gap up over the previous day.
Engulfing Pattern – Bearish
When a small white body appears in a uptrend and next day prices opens at a new high
and then quickly cooling off with closing below the open of previous day.
This pattern develops during an uptrend when there are more sellers than buyers. This is
represented by a large red candle engulfing small white candle. White candle represent an
up day while red candle represent down day.
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Engulfing pattern – Bullish
When a small black body is formed during a down trend and next day prices opens at the
new lows and then quickly move above to close above the closing of the previous day.
This pattern is opposite of the previous pattern and occurs when there are more buyers
than sellers. It displays long white body engulfing small colour body.
It indicates that security is bottoming out and trend may reverse to bullish.
Morning Star- Morning star is Bullish reversal pattern; they have gaps before and after the
middle day's body.
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Evening star – It is Bearish reversal pattern. It follows an uptrend and should have gaps
before and after the middle day body.
It is one of the most easily identifiable patterns and formed quite often.
Harami – Bearish – Harami bearish pattern is another easily identifiable and shows a red
candle completely inside previous day's candle. It indicates that up move is approaching
end.
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Harami – Bullish – Harami Bullish is quite similar to harami bearish it’s just that it is
opposite in nature. A small white candle is seen inside red candle and indicates that
downtrend is approaching its end. A higher close would confirm the trend reversal.
These are few important formations in Candlestick chart. Traders need to be careful while
trading them. It is very important to understand no formation or chart can tell the entire
story. They need to be confirmed with the use of other indicators before taking any call on
them. We will discuss these indicators in later chapters. These formations are the part of a
candlestick chart but there are other patterns which are very important like head and
shoulder pattern. These patterns indicate breakouts and other vital information like support
and resistance. We will discuss those chart patterns in later chapters.
Points to remember;
Candlestick charts are one the most widely used charts.
There are formations on the charts which throw light on vital information.
Multiple pattern or formation should be used to confirm a signal before taking the
final bet on it.
We will cover other indicators and chart pattern in later chapter so go through before
using it.
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Chapter 3- Trend Lines
It is the most important concept in stock market. Trend is the biggest thing in any phase in
market. It is probably the only concept which is not only very important for traders or
investors but also relatively easy to judge. Technical analysis assumes that price movement
always follow trends. In an uptrend, prices move higher and in down trend, they slide like
cards.
A line which is drawn to connect few important points in a chart to judge its trend is called
Trend line. This is quite easy to draw and the most powerful tool to understand the market.
Earlier traders use to manually draw trend lines on technical charts but now with
emergence of software, it has become very easy to draw and understand these trend lines.
Drawing a Trend line
As mentioned earlier, with the use of software, it is quite easy to draw trend line. A trend line
is drawn by connecting two or more points on same plane. They connect a series of high or
low points in order to determine an up or down trend. At least two points should be
connected using a trend line to confirm the trend. They are used by traders to initiate or exit
a trade. Breach of the trend line indicates trend reversal and that point used to exit
positions.
Figure 3.1- You can see two trend lines are drawn using up and low points.
The starting point of the first trend line is September 2010 when prices were at their lower
levels then this up trend continued till October and then prices were in down trend from
November 2010 onwards.
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Up Trend line
As shown in figure 3.1, an uptrend line is inclined upwards and has a positive slope. It is
drawn by connecting two or more low points. The second low must be higher than the first
point. Up trend line act as support and should be used as exit point if it is breached. The
breach of up trend line is considered as sign on trend reversal.
Figure 3.2- we have used the same chart which is being used in the previous chart.
As you can see the breach of uptrend is followed by the fall in prise.
Down Trend Line
Contrary to the uptrend, down trend line is drawn by connecting two or more high prices. It
act as resistance and to draw this second price point should be at the lower level than the
first point and so on. It has a negative slope, and if it is breached it is a sign of trend
reversal. So if there are short positions in the security then one must exit at that point.
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Figure 3.3- This chart displays down trend line and their breach indicates reversal of
the down trend.
Trend confirmation
As discussed earlier, it is very important to understand that unless until two or more points
are not connected in a series, a trend line cannot be drawn. Third point in same series
confirms the trend. One should not force a trend line and it should be natural. Sometime
highs or lows cannot be matched together to form a trend line and it should not be drawn
artificially. Investors should verify volumes, support and resistance for further confirmation.
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Figure 3.4- In this figure, you can see SBI's chart. The first line a up trend line which
act as support and each time price touch, it rebounds. The second trend line is down
trend line which act as resistance and the security is failing to breach it.
One should be very careful while drawing a trend line and space between high or low points
should be given special care. If the space between two points is less and they are very
close to each other, then the validity of those lines is very suspicious. One should also pay
attention to the angle of trend line; they should not be absolutely high or low. An
approximately angle of 45 to 60 degree would be fine but again, it comes with the practice
and there are no guidelines for this specific information. So investors should search for
those trend lines which are more spontaneous in nature.
Figure 3.5- it displays’s SBI's chart for period of five years. The upper and lower
trend line acts as resistance and support levels and trade should be taken
accordingly. Trend lines are very good tool to judge resistance and support levels.
Trend channels
Trend channels are integral part of technical analysis. In trend channels, parallel trend lines
are drawn who act as boundaries for price movement. One trend line joins the higher point
and the second parallel line is drawn joining lower points. These channels are used heavily
by traders to generate profitable trade. Long position are initiated when prices move up
after touching lower trend line and short positions are initiated when price starts falling after
touching the higher trend line. Positions are excited when price touches the opposite
parallel trend line. Channel lines are used to entry and exit position.
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Figure 3.6- This figure display trend channels, long position should be initiated when
prices start increasing after touching the lower the trend line and exit it once it
touches the upper trend line and short position should be initiated price starts falling
after touching the upper trend line and exit their position once it reaches the lower
trend line.
Figure 3.7- It shows reliance industries trend channel see how it has moved in this
range and rebounded after touching trend line at both ends.
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Points to remember
Two or more points should be connected together to confirm a trend.
Trend line should not be very steep.
Trend line should not force and artificially drawn, it should be drawn using matching
points.
Trend channel should be used a trading range and for figuring out the entry and exit
points.
Trend lines and trend channels should be used along with other indicators to confirm
a trend.
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Chapter 4 - Chart Patterns 1
Head and Shoulder Pattern, Inverted Head and Shoulder Pattern, Failed Head and
Shoulder Pattern
We have already studied charts, its formations, Trend Lines, support and resistance. The
most important and difficult task in trading is to figure out entry and exit points. One other
important and difficult issue faced by most of the trader is to figure out the Top and Bottom
in respective phases. History often repeats itself in stock market and rise and fall, both are
bound to cool off. So, by analysing its historical movement, we can figure out its entry point
and then exit. There are pattern formed everyday on chart which can be studied to judge
these points and time along with using Trend Line and Trend channels. There are multiple
patterns which can be found but we are going to focus on few important ones.
These chart patterns are classified in two categories;
1.
Reversal patterns
2.
continuation patterns
We will go through them in details; first we will cover Reversal patterns.
Reversal Patterns – reversal as the name suggest indicate change in current ongoing
trend. These are formations on a chart due to price movement in certain patterns. These
formations can be found on all time frame charts like daily, weekly or monthly charts.
Reversal does not indicate bull or bear run on its own, it’s just indicate that ongoing trend is
getting weaker, and market or a particular security will start moving in opposite direction
from example- if the current trend is up, trend may reverse and prices starts to move in
downward direction and vice versa.
These patterns are a bit lengthy and take some time to complete. Only when they are
complete, a trend reversal should be established because in some incidents, it may stop at
some stage before completion and ongoing trend may again resume.
Breaking of a trend line is often the first signal of trend reversal. But before confirming the
trend reversal one must understand the current trend, if there was no clear trend at the time
of this formation development on the chart, taking that as trend reversal may not worth. So,
presence of a trend is imperative to the concept of trend reversal.
Strength of the pattern can be judged by the height and width of the pattern, height and
width of the chart pattern are directly proportional to it strength.
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Now we will discuss these patterns;
1.
Head and shoulders Pattern
A head and shoulders pattern is formed when an uptrend is approaching its end. With this
formation, trend reversal is indicated.
This formation consists of three peaks with the middle peak being the highest. Overall
structure resembles Head and should and that is why, it is called so. Middle peak becomes
Head and other two peaks at the right and left becomes shoulders. Lows of these peaks
can be connected to form a support line which is called Neck Line.
Figure 4.1- Head and Shoulder Pattern
Always look at the volume while trading in stock market at any stage. So, if volumes
associated with the first, second and third peak are high, it authenticate the pattern or else
one need to be more cautious and should pay attention to other factors.
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Figure 4.2- This is ICICI Bank chart which shows the formation of left shoulder in
March 2010 with good volumes then Head in April and the pattern was complete in
May with the formation of Right shoulder. As you can see prices went down after this
pattern and remained in the lower zone till August when it started its up move.
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Figure 4.3 – Sail made this pattern in November 22 to January 10 2010.
Figure 4.4 – Head and Shoulder pattern was seen on Tata Motors in December 2010
with good volumes and prices started falling after that.
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Figure 4.5- This is satyam chart when stock fell sharply after Head and Shoulder
Pattern and as it was accompanied by high volumes, fall was quite prominent.
2.
Inverted Head and Shoulder Pattern
Sometimes a head and shoulder gets inverted, this inverted Head and Shoulder indicates
the reversal of a down trend. One need to look at the volumes before confirms the reversal.
Volumes play a major role in this pattern. They require more time than Top reversal Pattern
to complete. They are also called bottom reversal pattern.
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Figure 4.6- HPCL formed this pattern between Jan 2010 to July 2010. After
completing this, stock surged with high volumes.
Figure 4.7- This is Canara bank which showed this pattern and after that stock
started rising.
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3.
Failed Head and Shoulder Pattern
Stock market is full of surprises and often unexpected events happen here. So sometime
when a pattern is about to complete, some unexpected event changes it course and the
patterns fails. This is observed with the Head and Shoulder pattern also and when it
happens it is called failed Head and Shoulder pattern. Though, Head and Shoulder is a
very reliable pattern but nothing is fixed here. In these cases, instead of falling after forming
right shoulder, prices shoot up. A failed Head and Shoulder is often observed when the
patterns in two time frames are contradictory. So, it is very important to take position when
it is completed and the next course of price movement has started.
Figure 4.8- It shows a failed Head and Shoulder Pattern where prices went up after
forming right shoulder.
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Figure 4.9 – Failed Head and Shoulder Pattern was observed in Cipla where after
forming right shoulder, price went up.
Points to remember
A reversal pattern does not indicate a pattern on its own but simply indicates reversal
of the current trend.
Head and shoulder pattern indicates reversal of uptrend.
Inverted Head and shoulder indicates reversal of down trend.
Failed Head and Shoulder pattern indicates up trend.
Volumes are key factor in reversal pattern.
Support and resistance level need to be monitored carefully.
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Chapter 5 - Chart Pattern 2
Double Top Pattern, Double Bottom Pattern, Broadening Formation
We have gone through Head and shoulder reversal pattern in last chapter. In
continuation of the reversal pattern, we will cover some other important reversal
patterns in this chapter. These reversal patterns are of great significance in falling or
rising markets. We can gauge the future trend and therefore, can take call in future
directions. We should always trade in the trend, so these patterns will help us in
determining the future trend.
The first reversal pattern which we are going to cover in this chapter is;
1.
Double Top (Reversal) pattern
Double top pattern is often observed after an extended up trend. The pattern is made
up of two peaks which are almost equalled (not exactly equal) and there are smaller
troughs in between these two peaks. An ideal Double Top Pattern will initiate down
trend, but unless support levels are broken, it cannot be confirmed. So, after it is
formed, wait till support level is broken. To authenticate a Double Top pattern, verify the
current trend, if there is no clear up trend, and then it cannot be established.
First peak should be the highest point of the current trend, and then it is followed by
some correction. This phase of correction can exist for some time. Once this correction
is over, it will form the second peak. This peak is often associated with low volumes.
After achieving this peak which is almost equal to the first peak, it will start falling. Fall
would be quite rapid with high volumes. Once support is broken, this pattern can be
confirmed.
Figure 5.1 - It shows TATA Motors formed this Double Top Pattern between 2006How to Trade with Technical Charts
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2007 and after that stock witnessed a steep fall. Note how prices remained around
the bottom line which acted as a support and once they breached it, there was no
support in the near term.
Figure 5.2 – This figure displays Maruti Suzuki which formed Double Top patterns
in Oct 2010 and after stock that stock corrected sharply.
Figure 5.3 – This figure displays Kingfisher which made Double Top Pattern
between Oct to Dec 2010 and corrected after that.
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2.
Double bottom Pattern
Double bottom pattern is formed when prices in a down trend keep on falling and
make first bottom, then they rebound for short term and form a peak and again start
falling, once they have reached a level which is almost equal to the first bottom (second
bottom), they start rising. This is somewhat W shaped and volume is the key here. It
indicates the beginning of the Bull Run and provides great levels to enter the stock. But
its failure rate is also quite high so one needs to look at other indicators also before
taking the final decision.
Figure 5.4 – It displays a W shaped structure where prices continued to fall till
they reached first bottom, then they rebounded and after making a peak, they fell
again. Once they touched the bottom made by first one, they rebounded
continued rising after crossing the peak.
This is one of the most easily available and recognizable pattern. It happens quite
frequently and is often misjudged by the investors. One should pay close attention to
the volumes and only confirm it once the structure is complete.
Next figure shows the point at which initiate the long positions but one must take care
while implementing it as we need to be extra cautious while using this pattern.
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Figure 5.5- Here we have tried to show the point which can be used for buying.
This is for informative purpose and decision should be taken after looking at
other patterns and indicators. The point of intersection can be used for initiating
long calls.
Figure 5.6 – Infosys tech made double bottom pattern. After this, stock has
witnessed a steady rise in its stock prices.
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Figure – 5.7- It shows Educomp which was falling since Jan 2008 and then it
made Double Bottom in End of 2008 and pattern was complete in April 2009. After
this, stocks managed to maintain it’s up movement for a year.
Figure – 5.8- This is chart of Mphasis where you can see how this stock took
some time after complete Double Top Pattern before stock went into a Bull run.
You can see the way volume was behaving during the pattern and at the time
when prices went up.
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3.
Broadening formation
Broadening formation is shown by two diverging trend line. It is witnessed in a long
volatile market where there are no clear direction and market move in zigzag fashion. It
indicates the reversal of the trend. It is often Bearish in nature. These are formed when
there is indecision in the market and bull and bears are pushing each other. Stock might
be going through a series of high and lows. This is quite rare and not easy to figure out
but it is very reliable and often associated with extreme falls.
In this pattern, first there is a rally to a new high, then stock weakens to an
intermediate support level, and then it is followed by a second rally to a higher
high on increased volume and then again decline through the intermediate
support level. A third rally to a higher peak with high volumes followed by a
collapse. The measured target is derived by subtracting the height of the pattern
from the eventual breakout level.
Figure 5.9 – it shows how Nifty formed multiple peak where first two peaks were
almost equal so they were considered as first peak then they are followed by
second and third peak. After this pattern in Jan 2008, nifty collapsed and went
through a series of lows.
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Figure 5.10- this figure shows how Unitech formed three peaks before it finally
collapsed in November 2010.
Figure 5.11 – this figure shows the broadening formation in SBI which happened
between Sep 2010 to Nov 2010 and after that stock started falling with increased
volumes because bears were dominating the market.
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Points to remember;
Always verify the current trend and volume.
Reversal pattern indicates the reversal of the current trend.
Unless, until reversal is confirmed with the pattern completion, don’t initiate a
trade.
An ideal Double Top pattern will initiate down trend.
An ideal double bottom pattern will initiate an uptrend.
Broadening formation is often bearish.
Use these patterns in conjunction with other indicators.
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Chapter 6- Chart Patterns 2
Ascending Triangular Pattern, Descending Triangular Pattern, Symmetrical
Triangular Pattern
We have gone through some of the most important reversal pattern. These reversal
patterns indicate reversal in the current ongoing trend, but it doesn’t mean we don’t
have any patterns which indicate the continuation of the current trend. Most of these
patterns are formed during a trend due to the certain pattern of buying and selling which
happens in scrip. As mentioned earlier, markets repeat it and always follow a pattern,
here too, we can figure out certain pattern which will help in making sure that we remain
in trend and carry trade in correct direction.
These continuation pattern are the part of the market course and are always repeated
when market follow same trend. So in case of an uptrend, formation of these pattern
indicates accumulation, once can either buy more stock or remain in positions where as
in a down trend, one can continue with short positions.
Now we will go through some of the most important continuation patterns.
1.
Ascending Triangles Pattern
This is a Bullish pattern which is formed during a bull run. Though, some time it can be
seen during a down trend also, but then it act as a reversal signal which is quite rate. S
it is considered as bullish pattern because it is often associated with the uptrend.
This indicates that bullish run is in the continuation and investors can hold their long
positions. This is triangular in shape with one horizontal line; one vertical line and a third
ascending line joins these lines. The phase in which these patterns are formed are
resting phase where a stock consolidates and then again resume its upward movement.
This pattern is often seen with a reduction in volumes. Though once pattern is complete
and stock passes break out zone, volumes are increased. While trading ascending
triangles, investors should verify the current trend, volume with which stock has risen
and the trend line. Once the breakout has occurred, the target price is calculated by
measuring the widest distance of the pattern and applying it to the resistance breakout.
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Figure 6.1 – figure shows how a ascending triangular pattern look like. Important
points to look for in this pattern are the bottom trend line, peaks should be almost
equal and the scrip should be able to break out after this with good volumes.
Figure 6.2 – SBI formed this structure in the above figure with good volumes,
stock was in uptrend and after consolidating at this level, it resumed it uptrend.
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Figure 6.3 – This is Tata Motor’s chart which shows how ascending triangle was
formed during April – July 2010. After this, stock made new highs.
Figure 6.4 – This is Infosys where it made ascending triangle in May – Sep 2010
and stock continued its uptrend after that.
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Figure 6.5 – Yes bank made ascending triangle between April 2010 to Aug 2010
but volumes were not very good, though stock made a high after completing the
structure but was not able to sustain the rally for too long and broke.
2.
Descending Triangles Patterns
Next in the row of continuation pattern is descending triangle patterns. As the name
suggest, they are opposite of the Ascending Triangle Patterns. They are Bearish in
nature. They are formed due to redistribution of the scrip. They indicate that security is
consolidating at the level and will resume the down trend.
Structurally also, it is opposite to the Ascending triangle as Horizontal line in this pattern
forms the base line which drawn by connecting lows and it is joined to a descending
trend line. A perpendicular vertical line completes the structure.
One of the most important factors in trading Descending triangle is to watch out for
Support levels. Breach of support level confirms the down trend and is a good point to
initiate short sell.
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Figure 6.5 – it shows a descending triangle pattern. Multiple lows and high can be
joined together to form this pattern. Break out confirms the resumption of down
trend.
Figure 6.6 – DLF formed Descending triangle in Nov- Dec 2010 and stock has
witnessed a consistent fall since then.
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Figure 6.7 – Tata Steel formed this pattern with good volumes and once support
was broken which is represented by the horizontal line, stock started falling with
high volumes which indicates a complete collapse.
Figure 6.8- This is GMR infrastructure which formed Descending triangle between
Nov 29 2010 to Jan 10 2011. Stock has been in downtrend for some time and this
pattern confirms the future down play.
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3.
Symmetrical Triangle Pattern
Symmetrical Triangles are usually continuation pattern which can either be Bullish or
Bearish depending upon the current trend. Trend is confirmed only after the break out.
They are formed of converging lines which are formed by connecting multiple highs and
lows.
They offer very good indications to initiate long or short position based upon their
direction. This is the resting phase for the stock after which it takes on its current trend.
There should be an established trend for symmetrical triangle to qualify as a
continuation pattern. There should be at least two highs and two lows to complete the
structure.
Support and resistance level should be carefully monitored during this pattern and the
positions should be taken in accordance to the current trend. Volumes should be
watched during this pattern and strength of the pattern is directly proportional to the
volumes. So, if break out happens with high volumes then the rise or fall is quite fast or
else, movement would be slow and only pick up once there are volumes.
Figure 6.9- this figure displays a symmetrical triangle pattern. Prices may move
up or down based upon the existing trend. Volumes and Break out should be
carefully monitored.
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Figure 6.10 – Uptrend started in July 2009 in SBI, it remained in uptrend till Dec
2009 when it went into resting phase and started symmetrical triangle formation.
Structures were completed in April 2010 and break out happened with high
volumes, up gained strength and stock remained in upper territory.
Figure 6.11 – in this figure, Tata Motors started falling at 1st point in Jan 2007 and
it continued falling till July 2007. Then it underwent the resting phase starting 2nd
point in august 2007 and completed the structure at 3rd point. After completing
the structure, stock made series of lows
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Figure 6.12 displays ICICI bank which formed this pattern and then prices went
followed the initial up trend.
Points to remember
Ascending triangular pattern is a continuation pattern which indicates further up
move.
Descending triangular pattern is continuation pattern which indicates further down
move.
Symmetrical triangular pattern indicates the resumption of the existing ongoing
trend.
Symmetrical triangular pattern indicates neither bull nor bear run. It just indicates the
resumption of the existing trend.
Volumes are key factor and determine the strength of the pattern.
Support and resistance are should be carefully monitored.
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Chapter 7 – Chart Pattern 3
We have already gone through the reversal and continuation patterns. As mentioned
earlier, reversal pattern indicates the change of the trend in opposite direction and
continuation patterns indicates resumption in the same direction. We are further going to
look into formation which are classified as continuation pattern and are of great
significance while trading in stock market.
We have discussed few continuation pattern like ascending triangular pattern, descending
triangular pattern and symmetrical pattern. These are large structural patterns which
require more time to complete. There are other continuation pattern formations which are
smaller and can be regularly seen in a trend market.
They mark small consolidation phase in which a stock move around one point for some
and then resume its move. Break outs are often associated with high volumes.
Continuation Flags
Flags are small formations which develop in a trending market. They can either be bearish
or bullish depending upon the formation and current trend. They are known as Flags
because the shape resembles a flag hanging off a flag pole. They are of great strategic
importance in stock market and are thoroughly used by the traders worldwide. They
indicate a consolidation phase after which stock resumes its ongoing trend.
It is composed of two parallel lines which act as support and resistance. At least two highs
and lows should touch these parallel lines for an ideal flag. The slope of the flag is always
in the opposite direction of the current ongoing trend. If the current trend is up, then the
slope of the flag would be low and if the current trend is down, and then flag will point
towards upper direction. As we have seen with other patterns, here also, volume is the
king maker. Strength of the pattern is directly proportional to the volumes. As with other
aspects of technical analysis, flag patterns are not perfect and other indicators should be
verified.
1. Bullish Flag - These are pointing the lower directions and are formed of two parallel
lines. These are smaller structures so one needs to pay more attentions to figure out
them. These parallel lines act as support and resistance. Unless until, support is
breached or resistance is broken, a valid pattern is not confirmed.
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Figure 7.1 – A Bullish flag will resemble given picture with two or more highs and lows
touching parallel lines and then breaking above the upper line.
Figure 7.2 - SBI formed this pattern in May 2010 and after completing it, stock resumed
its up move.
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Figure 7.3 – Bullish flag was seen in BHEL in June-July 2009, after consolidating at
current level, stock resumed its up move.
Figure 7.4 – Bullish flag was formed in Dr. Reddy in July-Aug 2010 and stock
resumed its up move after the resistance was broken.
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2. Bearish Flag
The exact inverse of the Bullish flag is known as Bearish Flag. Structurally, it is same
except that slope of the flag is upward. It is also composed of two parallel line joining two
or more highs and lows. The pattern is not bearish until support level is broken and stock
moves below that. Volumes are very important in Bearish flag also. Like bullish flag, it
isn’t perfect. Investors should verify other indicators before initiating the trade.
Figure 7.5 - A Bearish flag will resemble given picture with two or more highs and
lows touching parallel lines and then breaking below lower line.
Figure 7.6 – Reliance formed this formation on a daily chart and as you can see it kept
sliding after completing the structure. Increased volumes at the later stage added to
the fall.
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Figure 7.7 – HDIL made this bearish flag in June- September 2010. Stock was in a
downfall and after consolidating in this zone, it resumed its downfall in august 2010.
Figure 7.8 – HDFC made this bearish flag in a 5 day chart around 31st Jan 2011 and
support was broken with high volumes. Stock witnessed a steep fall after that.
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Pennant Patterns
Pennant Patterns are similar to flag patterns but they are formed of converging lines instead
of parallel lines. Pennants are continuation patterns which are often seen with flags and are
consolidating phase for a security. In a trend, security prices changes rapidly, after each
spurt in either direction, they will take rest and therefore, forming Pennants.
Like flags, Pennant too is smaller in structure. Sometime, they look like symmetrical triangles
but pennants are too small in comparison of symmetrical triangles. Pennants are also
classified as bull Pennant and Bear Pennant.
Bull Pennant
The bull pennant pattern is formed during an uptrend. This pattern is named for the
resemblance of a pennant on a pole. The bull pennant is a continuation pattern with
narrowing price action following a strong advance. When price crosses the upper trend line
i.e. resistance, it is the buy signal. Volumes, support and resistance are key factor to follow
while trading Bull Pennant.
Figure 7.9 – figure shows a Bull Pennant, structure many vary slightly, but important
points are two converging trends line in up trend. These trend lines will join more
than highs and lows and finally break out.
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Figure 7.10 – Tata motors was in Bull Run since 2009. Pennant was seen in June-July
2010. Please note break out happened with rise in volumes, then stock continued its
up journey and shot up significantly.
Figure 7.11 – M&M was in a Bull Run between 2008 to 2010. Stock made lot of bullish
flags and pennants during this period. In this figure, you can see a bullish flag and
pennant together. There formation is associated with rise in volumes which
strengthen the pattern and therefore, stock continued its bull run.
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Bear Pennant
The bear pennant pattern is formed during a down trend. This pattern is named for the
resemblance of an inverted pennant on a pole. The bear pennant is a continuation pattern
with narrowing price action following a constant decline. Structure is completed with the
penetration of the support line. This is the sell point.
Figure 7.12 – This figure shows the structure of a Bear Pennant. Volumes, support
and resistance level are key factors to watch out in this pattern. Sell signal is
generated only after support is broken.
Figure 7.13 – Suzlon Energy was in down trend in 2010. Stocks showed bearish flags
and pennant. Support was broken with high volumes and stock remained in lower
zone.
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3.
Rectangles
Rectangles are very easy to read and like many other patterns, are quite common. They are
formed when a stock rallies to touch the resistance level, then falls to the support level and
again follows the same trend of going up and then coming down. They are continuation
patterns. They are formed in trading ranges which act as a consolidating phase when stock
consistently test resistance and support levels. The pattern is not complete unless break out
occurs. They composed of two parallel lines where the upper line is resistance and lower
line represents the support.
This is seen in a market where Bull and Bear are consistently pushing each other and each
time stock rallies to the peak, it is sold by the trader which brings to the support level. At
support level, they are again bought by the investors. This cycle continues till break out.
Break out is associated with high volumes. Rectangles are neutral on their own and one
need to verify the direction of the break out to confirm the trend.
Figure 7.14 – This figure which depicts a rectangular pattern. Break out can occur in
either direction.
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Figure 7.15 – Reliance Industries in chart kept on trading in a range before it finally
resumed it down trend. As you can see break out was associated with high
volumes.
Figure – 7.16 – You can see how HDIL was in a down trend and made this rectangle
pattern in July – Oct 2010. Break out occurred with the rise in the volume and stock
remained in down trend.
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Points to remember
Continuation pattern indicate continuation of the current trend and do not indicate
any trend.
There should be an existing trend for a continuation pattern. In absence of a current
trend, similar formations would be discarded and not considered as continuation
trend.
Unless until break out happens, pattern is not complete.
Always verify volume, increase in volume confirms the pattern.
Continuation flags and pennants are smaller structure and take less time to
complete.
Bull flag is sloped down ward and bear flag is sloped upward.
Bull pennant is sloped down ward and bear pennant is sloped upward.
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Chapter 8 - Moving Averages
Now as we have gone through the charts, trend lines and its patterns, we have a broad
understanding about how price movement happens in stock market. It is very important to
understand them. They pave way for the future course and by understanding them, we can
make out a lot about stock market. Now, we will go through something which is the most
important factor in stock market. It is the biggest indicator of the current status and future
course. They are known as Moving average. As the name suggest, it is the average of the
prices in certain time frame.
They measure the prices of the security over a period. As the prices keep on changing, so
as the moving average. Moving averages are trend following indicators and they are used
as momentum indicators. It also represent the current mood of the investors and the
direction in which crowd is measuring. Moving average is the most important factor for
support and resistance and if moving averages are moving in downward direction, it mean
bear are dominating bulls and if they are moving upward, then vice versa.
Moving averages are classified into two categories;
1. Simple Moving average
A Simple Moving average is the average of the price over a certain period. Most moving
averages are based on closing price. A five day simple moving average is the average price
of the five days which is calculated be adding closing price of five days and then dividing it
by five.
5-day SMA: (11 + 12 + 13 + 14 + 15) / 5 = 13
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Figure 8.1- This chart shows two simple moving average for Reliance Ind. we have
taken 5 day SMA for short term and 200 day SMA for long term. When short term
moving average move below longer term, it is indication that support has broken and
stock will move downward whereas short term moving average move above longer
term, it indicates that stock is about to move upward.
Figure 8.2 - This is SBI's chart where we have used 20 day SMA and 50 day SMA. Red
line is 20 day SMA and 50 day SMA is represented by green line. Shorter term SMA
went below longer term SMA and since then stock has been trading in the lower
zone.
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2. Exponential Moving Average (EMA)
The exponential moving average gives more weightage to recent prices in an attempt to
make it more responsive. EMA is calculated by adding some percentage of the previous
day's moving average to a percentage of the current day's closing value. EMA's calculation
is a bit complicated so we won't get into that because now they are done by softwares.
Exponential moving average is better than SMA in judging the trend because of the fact
that it gives more importance to recent changes in prices.
Figure 8.3 - In the given chart of Nifty, red line represents the 20 day EMA and 50 day
is represented by green line. Moving average reflects the sentiments of the crowd.
EMA follows price changes much sharply than SMA. As you can see, line also drops
as soon as the price drops.
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Figure 8.4 - This is SAIL's chart. As you can see, the shorter period moving average
is consistently below the longer period moving average and so as stock has been
consistently in lower zone.
Figure 8.5- This is BHEL chart where red line represents 20 day EMA and green line
represents 50 day EMA. At point 1, red line is moving above green line and stock is
in uptrend and at point 2, the moment price start falling, red line crossed green line
and moved downward.
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How to use Moving Averages
Moving averages are widely used by traders to forecast future trend, supports and
resistance. One longer period average is used with one smaller moving average. The
primary step in using moving average is to identify the period which one want to use. The
12 and 26 day EMAs are normally used for short terms, 20 day and 50 day moving
averages are used medium term and 100 day and 200 day EMA is used for long term.
Commonly used EMAs are;

short term - 20 day EMA

medium term - 50 day EMA

long term - 200 day EMA
Moving averages are used for many purposes. They are used as a tool to predict trend, to
know the support and resistance. But gradually moving crossovers are becoming very
popular. Now we will go though how these crossovers work.
Crossovers
Crossovers are widely used in technical analysis. In fact, crossovers are used more than
just moving average alone. There are two types of crossovers which are used in technical
analysis. The first one is when price of a security changes its direction and close above or
below the moving average. This is the indication of the trend reversal. Though, it can be
only confirmed once support or resistance levels are breached. When prices are not
showing any sign of moving above or below of the moving average and are trading
sideways. Don’t taking any position during that period.
So, in a particular scenario, say prices have broken the resistance level and remained over
that. You can initiate a long position and can remain as far as prices remain above moving
average. When price starts to fall and close below the moving average line. It is indication
of trend reversal and one should exit the position as soon as prices close below the moving
average.
The second type is when two or more moving averages are used where their crossover
points are used as entry and exit. As long as shorter moving average remains above longer
moving average, stock will remain in uptrend and the moment, it move below the longer
moving average, it is indication of trend reversal and in case of down trend line, if shorter
moving average cross above longer moving average, it is indication of the start of a
uptrend.
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Figure 8.6 - This is Hero Honda's chart where it went through multiple cycles of up
and down trend. You can see how prices remained below moving average in a down
trend and above moving average in a uptrend. Each Point 1-6 in this chart shows
points of trend reversal. This is the first type of crossover.
Figure 8.7 - It is Tata Motors which had a Bull Run in 2010. We have used 20 day EMA
(red line) and 50 day EMA (Green Line) in this chart. You can see at point 1 when
shorter moving average crossed longer moving average, the stock started rising and
continued to rise till point 2 when shorter moving average went below longer term
average Thus, indicating trend reversal where stock closed below the moving
average. This is the second type of crossover. Here point 1 is the entry point and
point 2 is exit point.
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Moving Average Envelopes
This is also a very effective technique to use moving average to trade. In this technique,
two moving averages are used which defines the upper and lower boundaries of the trading
range. Often, stock move in a particular trading range and each time they touch the extreme
point of the range, they reverse their directions. MA Envolpe is a good method to trade
these situations.
They are based upon percentage above and below moving average. It can be formed by
either simple moving average or exponential moving average. This act as band in which
prices move from one point to another in opposite directions and it act as trend following
indicator.
Figure 8.8 - This chart shows Moving Average Envolpe. Upper range act as
resistance and lower range act as support. Position should be taken based upon the
direction in which price move forward.
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Points to remember
Moving Average are momentum indicators.
SMA is slightly less responsive than EMA.
EMAs are more responsive and follow price movements more closely.
Both are equally equivalent depending upon the individual trading style.
Primary step in using MAs is to figure out time frame.
Time Frame should be chosen according to the time for which one can remain
invested in the stock.
Crossovers are very important tool to analyse entry and exit points.
They should be used in conjunction with other indicators.
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Chapter 9 - Indicators
In the last chapter, we have gone through Moving Averages which are momentum
indicators. These indicators are widely used and recognized for their ability to reflect current
market mood and predict future course. These indicators follow market trend and reflect
investor’s sentiments and momentum. They can be used to figure out to entry and exit
points.
There are several indicators which are used to predict future behaviour. But we should
target only few popular ones because targeting too many will lead to confusion. By going
through, we would be able to understand market trend in a much better way. We should
always verify volumes while using charts or indicators. Indicators should be used in
conjunction with the charts.
Charts along with indicators give full picture. Reading these indicators is very important
because most them posses few common and few different features. They all are unique in
some aspects and common in few. They all are plotted below charts and two or more
indicators should be chosen to confirm the trend. These indicators are classified into two
categories;
1. Lagging Indicators
2. Leading Indicators
Now we will cover these two categories in detail.
1. Lagging Indicators;
They are Trend following indicators and are always used in Trending market. They help in
understanding the trend and one can remain in the current position unless there is trend
reversal indicated by these indicators. They offer very few buy or sell signal. They are not
good for sideways market. It is very identify the current status of the market and use
indicators accordingly. Lagging indicators should not be used in a sideways market and vice
versa. We have selected few important Lagging indicators and now we will turn to them.
Moving Average is a lagging indicator which we have already discussed in the previous
chapter, so we will now turn to MACD.
Moving Average Convergence Divergence (MACD)
MACD is the first indicator in the category of lagging indicators which we are going to
discuss here. It was developed by Gerald Appel. It is a trend following indicator. This is
based on two moving averages. MACD measures the convergence or divergence between
a shorter and longer term moving average. When moving average move close to each
other, it results in convergence and when they move away from each other, it result in
divergence. It is one of the most effective and simplest indicators. It is very important to
read and understand.
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It is represented in two forms;
1. Line form.
2. Histogram
MACD Calculation
MACD: (12-day EMA - 26-day EMA)
Signal Line: 9-day EMA of MACD
MACD Histogram: MACD - Signal Line
MACD is the difference between two moving average.
How to use MACD
As mentioned earlier, MACD is one of the simplest indicators. It is very reliable and
produces a line which oscillates around a zero line.

If MACD is greater than zero, it means that the short term moving average is above
long term moving average. It indicates an uptrend.

If MACD is below zero line, it indicates a down trend.
MACD Crossovers
Crossover in MACD happens when MACD line move above or below the zero line. This
zero line is also referred as centre line. It is a signal to buy when MACD line move above
the zero line and to sell when line move below zero line. This crossover should be used in
conjunction with other indicators.
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Figure 9.1 - This is TCS chart, in this you can see how price went through up and
down trend when MACD move below and above the zero line.
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Figure 9.2 - This is Ranbaxy's chart, you can see the point at which MACD started
moving in different direction and so as the price of the stock.
MACD histogram
What we saw in the previous section was MACD line form. Now we will cover MACD in
Histogram form. It was developed by Thomas Aspray. MACD Histogram is the difference
between MACD and 9 day EMA trigger line. It is plotted in Histogram form. MACD
Histogram is easier than MACD line to read and understand.

If MACD is more than 9 day EMA, then the MACD Histogram will be positive i.e.
above zero line.

If MACD is less than 9 day EMA, then the MACD Histogram will be negative i.e.
below zero line.

The height and depth of the Histogram represent the strength of the trend.

If there is a sharp rise in Histogram bars, it indicates that bull market is strengthening
and when it falls, it indicates that Bull Run is weakening.

If the height of bar in increasing in the downward direction, it is a indication that bear
run is strengthening and vice versa.
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Figure 9.3 - This is Ranbaxy chart. In this chart, MACD histogram has been used. You
see how when MACD histogram was above zero line in a uptrend and below zero line
in downtrend.
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Figure 9.4 - This is Bharti Airtel chart where you can see positive histogram is
associated with the uptrend and negative histogram is associated with down trend.
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Figure 9.5 - In this chart of Lupin, you can see how taller bars were associated with
stronger down trend and as stock started rising, bars started moving upward and
gradually they crossed above zero line. Size of the individual bar is very important.
Their height is directly proportional to the strength of the trend.
Leading Indicators
Leading indicators are the one which lead prices. They are momentum oscillators and
consider the most recent change in price. They consider price movement in a fixed time
frame. As price of a stock increase, the momentum also increases. The rise in momentum
is directly proportional to rise in price of the stock. So, if the velocity of the rise is high, the
momentum will also be high. There are four main leading indicators;
1. RSI- Relative strength Index
2. Stochastic Oscillators
3. Williams %R
4. CCI- Commodity Channel Index
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We will now discuss my favourite three indicators here;
1. Relative Strength Index (RSI)
Relative Strength Index (RSI) was developed by J. Welles Wilder. It is used to measure the
strength and weakness in particular scrip. It is a momentum oscillator that measures the
speed and change of the price movement. It is a technical momentum indicator that
compares the magnitude of the recent gains to the magnitude of recent losses. They
oscillate in a range which ranges from 0 to 100. Lower level indicates oversold zone and
higher zone indicates overbought zone.
It can be measured for any number of days as per individual choice. The most common
time frame used is 14 day RSI. It is one of the most popular indicators. Though there is a
drawback associated with RSI is that it may produce false buy and sell signal if there is a
sharp rise or fall in security price.
Use of RSI
1. Buy if RSI start moving up after making second bottom.
2. Sell short as soon as RSI turns down after making second top.
3. If the falling RSI starts to rise, it is a buy signal.
4. If the rising RSI starts to fall, it is a Sell signal.
5. When RSI after falling to below 20 level and rallies above 30, it is a buy signal.
6. When RSI starts to fall and moves below 70, it is a Sell signal.
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Figure 9.6- In this chart of ICICI bank, you can see how each time RSI went up after
touching bottom, stock rallied. These circles display the point at which one should
place buy order to capitalize on the up side.
Figure 9.7- In this chart you can see RSI remained above 40 in an uptrend and
when it started falling after touching 80, stock went through a down trend. The red
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circle shows how RSI failed to sustain up trend and stop loss should be always used
while trading.
2. Stochastic Oscillators
Stochastic oscillators are momentum oscillator which was developed by George C Lane. It
compares the closing price of a security with its price range over a given period of time.
Stochastic is made up of two lines. These two lines are known as %K and %D line. They
oscillate between 0 and 100.
Reading above 80 is considered as overbought and below 20 are considered as oversold
zone. Oversold and overbought zone doesn't indicate buy or sell signal on its own. Price
may continue to rise even after crossing 80 or continue to fall even after crossing 20.

Buy signals are generated when both lines are in oversold territory and %K line
crosses above %D line.

Sell signals are generated when both lines are in overbought territory and %K line
crosses below the %D line.
There are three versions of the Stochastic Oscillator. These are;
1. Fast stochastic
2. Slow stochastic
3. Full stochastic
We are going to use fast and slow stochastic because they are more common and very
important from day trading point of view.
Fast Stochastic (original)
This is the originally developed stochastic oscillator. The stochastic has two lines, the %K
and the %D. The %K is the plotted instrument and the %D is the moving average of the
%K. The %K is more sensitive and it is the %D line that triggers the trading signals. As an
uptrend reaches its end; closes tend to approach the daily highs more often. And in case of
a downtrend reaches its end, closes tend to approach the daily low more often.
Figure 9.8 – This is fast stochastic which oscillates from 0 to 100. Blue line
represents %K and red line represent %D.
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Slow stochastic
Few traders thought that fast stochastic are too sensitive to price change and sometime can
throw false buy/sell signals. So they plotted a 3 day sma of the %K line rather than the
original (fast) %K. The new %D line would be calculated by the new (slow) %K. It resulted
in a smooth %K line. The problem with fast stochastic is that it tends to become choppy
where as Slow stochastic produces much stable chart.
Figure 9.9 – This is slow stochastic where %K is represented by blue smooth line.
Figure 9.10 – As you can see, slow stochastic is more stable and clear to read than
fast stochastic. Fast stochastic is very sensitive to price change therefore produces
frequent changes in the chart.
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Figure 9.11 – In this chart of HDIL, we have used fast and slow stochastic. As you can
see, curves in fast stochastic are steeper than slow stochastic. Sometime this leads
to a choppy chart which is hard to read and understand.
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How to use stochastic oscillator
1. When %K or %D falls below the oversold level and rises back above it, it is a buy signal.
2. When %K crosses to above %D, it is a buy signal.
3. It is a sell signal when %K or %D rises above the overbought level then falls back below
it.
4. Sell when %K crosses to below %D.
Place stop-losses below the most recent minor Low when going long (or above the
most recent minor High when going short).
Figure 9.12 – Tata Motors went through a lot of ups and downs. These ups and
downs are shown by trend line. You can see the slope of these trend lines. When
slope of the stochastic turns down ward, it is the signal of a down trend and when it
turns up, it is a signal of the uptrend.
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Figure 9.13 – This is Suzlon energy where we marked the buy and sell points. You
can see when %K crosses above %D, stock moves up and when it moves below %D,
it is a sell signal. Each time %K has moved above % D, stock has moved up and vice
versa.
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Figure 9.14 – This is Jain Irrigation’s chart. Like previous chart, here too you can see
when %K crosses above %D, stock moves up and when it moves below %D, it is a
sell signal. Each time %K has moved above % D, stock has moved up and vice versa.
3. William %R
William %R is inverse of the fast stochastic oscillator. It was developed by Larry William.
Williams %R oscillates from 0 to -100. Readings from 0 to -20 are considered overbought.
Readings from -80 to -100 are considered oversold. Williams %R reflects the level of the
close relative to the highest high for the look-back period. In contrast, the Stochastic
Oscillator reflects the level of the close relative to the lowest low. Signals produced by
stochastic oscillator are quite similar to William %R, so use either stochastic oscillator or
William %R. I prefer stochastic so we won’t go further in William %R because both
indicators are quite similar and they may create confusion.
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Other Important Indicators
We have covered almost all the important indicators in the current and previous chapters,
but there are two more indicators which I think we need to know. We should not use more
than three indicators simultaneously but as there are two indicators which are very
important and sometime become very important are;
1. Rate of change
2. Bollinger bands
1. Rate of change Indicator
Rate of change is a momentum oscillator which simply tells the percentage change in price
of the security in the current market and a time period in past.
ROC = (Close - Close N periods ago) / Close N periods ago * 100
It fluctuates in the form of a line above and below a zero line. When prices are high, it will
be high above zero and when prices are low, it will be low below zero line. It reflects the
momentum. High levels are overbought zone and lower levels are oversold zones. When
ROC is high, prices will move up and when it is low, prices will decline. Therefore, if ROC is
in positive side i.e. above zero line, its buy signal and if it is below zero line, it is a sell
signal. But like other indicators, ROC should be used in conjunction with other indicators.
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Figure 9.15 – Unitech was in down trend in August 2010 to Feb 2011. You can see
ROC remained below 0 for most of the time. Each time ROC went further below zero,
fall was accelerated.
Figure 9.16 – This is chart of IT giant TCS. TCS went through a lot of ups and downs.
You can see how High ROC is associated with uptrend and low ROC is associated
with down trend.
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2. Bollinger Bands
Bollinger Bands were developed by John Bollinger. They are volatility bands which are
placed above and below a moving average. They are extremely helpful in judging the trend.
They resemble moving average envelope in structure. They are composed of three bands
in which one band forms the middle band and other two bands are outer bands at the
opposite end.
Figure 9.17 – This figure shows a structure which resemble Bollinger band. It is not
exactly the same but the structure is almost same with two outer bands with one
inside.
The middle band is simple moving average that is usually set at 20 periods. The outer
bands are standard deviations. The width of the bands will increase in a volatile market, so
it indicates that market is not following any trend and in case of a trending market, the width
will reduce. A Bollinger band indicates overbought and oversold conditions.
 When the prices are trading close to the upper or lower band, it is signal that stock
may undergo trend reversal. Though, it is not the case always and one should
confirm it using other indicators also.
 When prices move above outside band, it is a indication of the Trend continuation.
 When prices are moving close to the lower band, it is a indication that price may go
up and when it is trading close to upper band, it is signal that prices may go down.
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Figure 9.20 – In this chart also, we have used TCS which has gone through ups and
downs. You can see each time prices were close to upper band, they came down and
when they were at lower levels, they went up. You can see how ROC responded so
closely to it. It is very important to use multiple indicators to confirm a pattern or
indication.
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Figure 9.21 – In this chart we have used canara bank. You can see prices remained
close to upper band for a long time starting from March 2010. ROC also oscillated
close to zero line. But RSI showed clear sign of uptrend and down trend. So it is very
important to confirm with multiple patterns and indicators.
Points to remember
Always use two or three indicators to confirm a signal.
Don’t use more than three indicators at once.
Always verify volumes.
ROC and Bollinger bands provide vital information so always use them.
Always trade with a stop loss and targets.
Practice these indicators before you apply them to your trade.
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Chapter 10 – Trade Planning
Now we have gone through all the important chart patterns and indicators. Technical
analysis is an ever evolving process. So this book is not the end of the road, it’s a beginning
for those who have read a book on technical analysis first time and for those, who have
already read books on it, another chapter. So as old saying goes ‘Practice makes perfect’,
we need to practice it on a daily basis. At times, even technical analysis can fail.
We all invest in stock market to make profit, not losses. So the most important aspect of
trading is its planning because planning is the only way which can take us to profitable
trades. Planning a trade is the most difficult task about it. We all can read numerous books
on technical analysis but one thing which no one can read anywhere is self discipline and
that is the key to successful trading.
Planning a trade
One of the most common problems faced by investors or traders is that they make profit in
small amounts and losses in comparatively big amount so their entire profit earned after
many good bets is often washed away by one or two big bad trades. Actual cause behind
this is money mismanagement.
Money management is the process by which we apply our money in a judicious manner
thereby minimizing risk of losing capital. We need to plan our trade or investment in
systematic manner.
Primary step in successful trading is to figure out the goal. Then we should analyze our own
risk appetite. Risk appetite refers to the amount of loss one can afford without losing
financial stability. Always take risk less than your risk appetite.
After analyzing your risk appetite, you should look at the time frame for which you want to
invest. It can be anything from intraday to 1 year. But unless until you know the time for
which you are investing it is very difficult to know what exactly you should expect from your
trade. For an extremely short term trader, a weekly fall would be loss where as for a
medium to long term investor, it may be an opportunity to add more stocks to the portfolio.
We often hear experts talking about the diversification of the portfolio. Diversification is
another mean to reduce the risk but over diversification can often create more problems
than solution. So, one should not get carried away and over diversify.
There is one more factor which often lead to the piling of losses i.e. we make some loss
and then to cover that loss, we increase our capital. And then again, we make some loss
and again, add more capital. This way we move further into losses and then recovering
from there becomes extremely difficult. So one should learn to control own emotions, greed
etc.
Profit and loss are the face of the same coin but we want to see only one face. But we
should be ready to see the other side also. And in order to prepare for that, we need to
capitalize on profitable trades. In case you face loss, go back to your trade and try to figure
out the cause of that.
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Always analyze your trade irrespective of the profit or loss. Never increase your capital out
of some emotional drive to recover your losses. If you had a bad trade, make sure you go to
the depth of the cause and till then don’t trade at all.
After you have figure out the reason, then look at the current market situation and take
decision accordingly. Don’t increase your capital unless until you had made 30-40 per cent
profit in initial capital. And when you decide to increase your capital, increase it in
installments.
Always enter in the market with a target and stop loss. If trade went wrong, only a proper
stop loss can save you. Before you enter into the market, there should be a target and stop
loss in your mind. Stop loss should be the support level and target should be the
resistance level.
How to put it together
You have gone through numerous technical chart patterns and indicator in book. Before you
start them implementing in real market. Try to practice them, apply your learning from this
book and see how they are working. Always remember one thing, in a bull market there is
no resistance and in a bear market, there is no support.
If market is consistently rising then it is a bull market and if it is falling consistently then it is
a bear market. Bear markets are very good for portfolio creation. You can get good stock at
very reasonable prices and at the same time earn money by short selling. In bull market,
you can capitalize on the market by riding the trend.
Now we know about technical analysis but you would be asking ‘where to start?’
Never start your trade before 10.00 am, let the market consolidate till 10.00 am and then
see if it moving up or down. From short term trading point of view, we need a list of those
stocks which can yield us good returns quickly. Now good returns don’t mean 100 per cent.
In short term, 10-20 per cent stands for good return, though at times we can make even
more.
We should start by looking at Volume Buzzers. Every major stock market portal provides
this information. Volumes are the king in the stock market. Volume represents the interest of
the traders. Higher volumes represent strength in the underlying trend.
Once you have the top 15 volume buzzers, you can move ahead with their chart analysis.
Rate of change indicator is a very good indicator for trending market. For details, refer back
to the chapter 9. But I am not saying that it is the best. You should use indicators based
upon the current market trend and other factors like economic and political news, quarterly
results and upgrades or downgrade by some major investment banks.
Now we will go through some examples using real time charts.
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Figure 10.1 – we have used Chambal fertilizers & chemicals in this chart. The stock was in
uptrend since June 2010 till Oct 2010. But volumes were low, RSI was moving around 60
and there were multiple crossovers in slow stochastic. It made a Head and Shoulder pattern
in Oct 2010 to Dec 2010 period. Simultaneously, volumes went up and at the break out %D
moved above %K (Bearish crossover) and there was fall in price from upper band in
Bollinger band. It is a confirmation that trend is going to reverse. So we have more than one
signal which is indicating trend reversal. So we need to try different indicators to verify the
current scenario.
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Figure 10.2- Tata motors was in uptrend since June 2010 Nov 2010. You can see at first
buy it started moving up from lower band in Bollinger band. Volumes increases and %K
moved above %D, so Bollinger bands, and volumes and slow stochastic, all confirmed an
uptrend. Then in late June, it fell a bit, short term traders can book profit and exit their
position at this point. Though, long term trader should not exit at this point. Then it started
its second up move in august 2010, prices went outside the Bollinger band, volumes shot
up and slow stochastic in overbought zone with %K remaining above %D for most of this
time. So investors should maintain their positions in the stock. In Dec 2010, prices started
falling from upper band of Bollinger band; investors should book their partial profit at this
point which is shown as Exit point. The trend reversal was confirmed by head and shoulder
pattern with good volumes and %D crossing above %D and fall in stochastic and RSI. All
indicators were pointing towards a fall at this stage. So, that’s how we need to very signals.
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Figure 10.3 – we have used Wipro in this chart. Red line represents 20 day EMA and
Green line represents the 50 day EMA. We saw a bearish crossover in June 2010 when
shorter moving average (20 EMA) went below longer moving average (50 EMA). This was
accompanied by a fall in ROC and MACD histogram also. So we can conclude that stock is
going to fall and we can initiate a short sell at this point.
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Figure – 10.4 – In this chart of HCL technologies, we have encircled the spots in chart
where there is a crossovers of the moving average. Red line represent shorter term moving
average and green line represent longer term moving average. We have used 20 day and
50 day EMAs. When a short term moving average crosses above longer term moving
average, it is a bullish signal and when longer term moving average crosses above short
term moving average, it is a bearish signal. Verify these crossovers with MACD and ROC.
Positive MACD and ROC will confirm bullish crossovers and negative MACD and ROC will
confirm a Bearish crossover.
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Points to remember
Always make you goal and stick to it.
Decide your time frame and then initiate your trade.
Never increase capital to recover your losses.
Increase your capital only after booking good profit on your existing capital.
Follow technical charts, they indicate all factors in the market.
Keep a close eye on the surrounding like news, current affairs etc.
Use more than one indicator to confirm a trend.
Never use more than three indicators together.
Trend is the biggest friend in any market.
Always enter market with a target and stop loss.
Never alter your stop loss, though at times you can revise your target.
Try to practice few charts every day.
You can select any charts of your choice but once selected, stick to that.
Use indicators based upon the market conditions.
Always invest systematically and never rush to the market.
Markets move in cycle of bull and bear phase, so don’t rush into a trade. You can
always catch it.
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